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Economic Analysis

Trading is a Useful Zero-Sum Game

There are two main issues with heated discussions one can find in trading forums about zero-sum games. The first issue is that most people believe that a zero-sum game is a useless one and its only aim is to redistribute wealth. This arises from a lack of understanding of the link between market trading activity and Economics. The second issue is that most people do not understand that the markets do not print any money and as a result, trading in itself is a zero-sum game as there is no way for anyone to profit without someone else losing money.

Zero-sum games are not always useless

Suppose that a philanthropist learns poker well and wins several competitions for the sole purpose of giving the money to the poor. In this case a zero-sum game is very beneficial to some poor people. But this is just a trivial example for the purpose of demolishing the universally quantified statement some people make that all zero-sum games are useless.

From an Economic perspective, the zero-sum game of trading is extremely useful because it is the main mechanism for price discovery and as a result greatly contributes to the optimum production and allocation of resources, which is the one of the main subjects of Economics.

Without commodity futures trading, which is a zero-sum game by definition and construction, commercial hedgers, like crop producers, wouldn’t be able to transfer their risk because of the absence of a speculator to assume it. Thus, it is not only a fact that the zero-sum game of trading is very useful for the society as a whole but also speculators are very much needed and in sufficiently large numbers.  This class of traders is always treated as scapegoats by politicians when they try to conceal their incompetence to regulate properly the markets. If those politicians understood Economics they would thank the speculators instead and even offer then tax incentives for their service to the economy. Of course, the markets should be protected from malicious speculation which aims at cornering markets but this type of illegal practice should not serve as an excuse to attack neither the zero-sum nature of the markets nor the speculators involved.

Trading is a zero-sum game by definition with a few exceptions

Some people fail to understand that the sum of the gains of the winners must equal the sum of the losses of the losers. There is no other way. In an effort to prove trading is not a zero-sum game, some use all sorts of arguments, like for example the fact that the number of participants always changes or that the sum of money is not constant. These arguments, although true, do not change the fact that the losses of the losers always become the winning of the winners with not a cent added or subtracted.

Let us suppose that all exchanges of the world were closed suddenly because money was abolished as a form of currency and personal labor was used instead. If all the records of all exchanges of the world for all instruments ever traded were reconciled, one would find after this monumental task that the sum of the amounts credited to traders as profits were exactly equal to the amounts debited from traders as losses, a zero-sum game.

Please note that I only talked about trading in the sense that someone opens a position with the objective of closing it after some time, seconds, hours, days, weeks or even months, with a profit or with a loss. I did not talk about investing, especially value investing. In such cases there may be generation of new wealth. Examples are technology companies like AAPL and new IPOs. An investor in such cases can earn money from dividends and stock appreciation without someone else losing the equivalent amount in cash although this is also debatable. Actually, someone loses the opportunity of the equivalent amount.

Just remember, whenever someone argues that trading is useless because it is a zero-sum game, respond that even the whole world started from zero total energy according to physics. The issue with trading is not that it is a zero-sum game, a fact due to its nature, but what those who win large sums do with the money.